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Features : Risk Management: Insurers Seek New Role In A Changing World

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Insurers are getting more involved in helping their corporate clients understand the risks they face.

Just four years ago insurance was a necessity rather than a dynamic component of a company’s business strategy—a determinedly unsexy but essential part of operations. Then, almost overnight, the insurance market changed. After the terrorist attacks on September 11, 2001, corporates had to rethink their own risks and how and why they used the insurance market.

Ian Clark, insurance partner at Deloitte in London, whose clients include Cable & Wireless and British Nuclear Fuels, recalls that prices in the insurance market increased substantially in the wake of 9/11 as the insurers involved sought to replenish their balance sheets. “There was a significant hardening in both pricing and terms,” he says.

Clark adds that “some corporates thought that what had occurred went beyond what was an acceptable price for technical risk transfer.” As a result, those corporates sought alternative means of obtaining insurance. Chief among those was a greater use of captive insurance companies—offshore-based arms of non-insurance subsidiaries. Parent companies transfer some of their risks to captives, which then usually keep some on their own books and pass on the remainder to reinsurers.

Andy Bulgin, group director of risk at Coca-Cola HBC in Athens, one of the largest bottlers of non-alcoholic beverages in Europe, agrees that increased prices and cover withdrawal by insurers forced businesses to look beyond the traditional retail route of buying insurance directly and instead encouraged companies to look at wholesale insurance through captives.

“Large companies, such as FTSE100 companies, already had sophisticated alternative risk financing strategies including captives,” explains Bulgin, “but the price increases forced many companies to realize that retail insurance might not be tenable in the long term. Even if you manage to avoid ridiculous price increases, you would have had to accept stricter conditions of cover; compromises would have to be made.”

Traditionally, captives had been used as a mechanism for efficient low-level risk retention, but as costs have increased, so has the scale of risk retention. “The hard market post-September 11, 2001, has led to a substantial increase in the level of retained exposure held by corporates through their captives,” says Deloitte’s Clark.

Neil Irwin, European development director at insurer Marsh (UK), agrees that companies are more willing to consider taking risks they understand on their own balance sheet. “The evaluation of the right level of retention of risk is something that has been increasingly explored by companies as the expense of primary cover has gone up,” he says.

As these captive companies have retained more risk, they have become a natural focus for corporate risk management, according to Clark. “The advantages of captives were historically largely tax related,” he says, “but in recent years they have become a mechanism for efficient risk management.”

Insurers Tackle New Risks

While the fundamental role of insurance has not changed in recent years, awareness of risk issues has certainly increased, Neil Irwin, European development director at insurer Marsh (UK), believes. “In our recent survey of over 900 European companies, the five key concerns were increased competition, adverse changes in customer demand, reduced productivity due to staff absenteeism and turnover, losing key staff to competitors, and changing demographics—risks that less than half of respondents felt comfortable with,” he says.

What is noticeable is that these are risks that are not insurable or at least difficult to insure. “Insurers are always looking to expand their business, and we have seen increased movement by the industry into specialist areas such as environment, security, brand and political risk,” says Irwin. “Of course, there are alternatives available for some of those risks—such as weather derivatives or catastrophe bonds—and the choice of companies will depend on their size and their market sophistication.”

But insurance is still a very efficient mechanism for distributing risks with an established infrastructure. “Other markets have yet to become so established, resilient or flexible,” says Irwin, “nor in many instances can they offer the same type of balance sheet protection offered by insurance.”

Andy Bulgin, group director of risk at Coca-Cola HBC, agrees alternative mechanisms for risk management still have some way to go. “Something like a weather derivative works on the correlation between bad weather and performance,” he explains. “That sounds ideal for a soft drink company. But even for us the correlation is not that clear.” He adds that the expense and complexity of derivatives make them less attractive. “The purchase of insurance is a conservative reaction to your business,” he says. “Any alternative way of reducing your risk is inherently more aggressive and therefore harder to convince the board of.”

Changing Attitudes to Risk

At the same time as companies have been transferring more of their risk to captive subsidiaries, there have also been major changes in the way they understand and manage risk in their operations and how they convey that to retail insurers. “Attitudes to risk among corporates have changed significantly in recent years,” says Marsh’s Irwin. “Many companies have invested substantially in risk management strategies.”

Those investments were in response to a number of events—9/11 and the collapse of Enron being only the most prominent. “The time invested by corporates in understanding risk has increased substantially in recent years, particularly with regard to operational risk and its implications for corporate governance,” says Clark.

Insurance companies have picked up on this increased interest in risk management and have tried to encourage it. “Those [corporates] without clear risk management strategies in place or who don’t understand the risk they are facing are less likely to be able to secure competitive access to the insurance market than in the past,” says Irwin. “We encourage clients to invest time with their underwriters to ensure a fuller appreciation of their risk management strategy and assure themselves that the right measures have been taken. The process has benefits for all parties involved. Companies that can demonstrate that they understand and manage those risks are always better placed.”

Coca-Cola’s Bulgin says there is some truth in saying that the insurance market is making efforts to better understand its clients—but it only goes so far. “The insurance market has become more scientific in the quality of risk being offered, and they are willing to try to understand your business,” he says. “But you have to be proactive. We always make a point of talking to insurers about both finance and risk management so that they can more fully understand our business.”

Equally, Irwin says, risk managers at some companies now do see risk management in a broader sense—that it’s not just about buying insurance anymore. “But the situation differs considerably between companies,” he says. “There are a few progressive companies that have recognized the clear link between effective risk management and improved business performance; they know it’s about anticipating and managing your business environment. As one company in Germany stated in our survey, ‘Effective risk management is about not missing opportunities.’”